Saturday, March 23, 2013

Money: is it immortal or does it die young?

Dreaming of Immortality in a Thatched Cottage - 1500s

Exogenous/endogenous money, reflux, hot potato money, helicopter money, inelastic vs elastic currency. These are all part of the colourful lexicon developed by monetary economists over the centuries to outline a general set of problems: how does money get emitted from source, and when, if at all, does it return to source?

We usually describe money as exogenous, hot potato, helicopter, or inelastic if it is emitted at the initiative of the issuer, and the issuer doesn't allow the public to exercise any initiative in returning this money back to source. Once it has been air-dropped into circulation from a helicopter, this kind of money becomes immortal, passing like a hot potato from person to person forever.

We describe money as elastic or endogenous when the money-using public exercises its own initiative in both drawing money out from an issuing source and pushing (refluxing) this money back to the source. This sort of money never strays far from its issuer, snapping back like a rubber band to be destroyed when it is no longer wanted. Rather than being a hot-potato zombie, elastic money lives fast and dies young.

There's a big debate among monetary economics about whether money is exogenous/hot potato/helicopter/elastic inelastic or if it is endogenous/elastic/refluxible. This debate goes all the way back to the banking-currency school battle of the early 1800s. Currency school advocates wanted to limit the note issuing power of private banks in order to prevent the overissue of notes, whereas members of the banking school believed such regulation unnecessary since in a competitive banking system, unwanted notes would simply reflux back to the issuer. The currency school won that debate, but the war continues.

I find it helpful to skirt around the skirmish and re-orientate the debate around finance, not monetary economics. This means that we've got to translate the language of monetary economists—hot potatoes, exogenous/endogenous, reflux, and the like—into the lexicon of financial instruments.

Let's head over to the stock market first. I'm going to hypothesize that the common stock is a thoroughly exogenous financial instrument. A firm decides when to issue new stock and at what price. Once stock has been issued, there's no way for an investor to automatically return the stock to the issuer. Stock wanders zombie-like through the financial world until the issuing firm is wound up, if ever. General Electric's original 1000 shares, for instance, have been hot-potatoing through financial markets since June 23, 1892.

Also found on stock markets are exchange-traded funds, or ETFs. Unlike stocks, though, I would say that ETFs are thoroughly endogenous financial instruments. Take the SPDR Gold Trust ETF. When investor demand for the Gold Trust heats up, ETF units will trade at a premium to their implied gold value. Large authorized-participants buy units from the ETF originator at par, paying with gold, and then sell these blocks to the public until the premium has disappeared. Vice versa when GLD units are at a discount to their real gold value. Now the authorized-participants buy units from the public at a depressed price and sell them to the ETF originator at par for gold. The result is that the quantity of outstanding units fluctuates quite widely, as the chart shows, but the price, specifically the premium/discount, stays constant. The public, through the intermediation of authorized-participants, sucks out whatever quantity of ETF units from the issuer that it desires, and then refluxes unwanted units back to it.

Unlike ETFs, bonds are exogenous financial instruments. Firms issue bonds when they need funding and these instruments stay outstanding until redemption date or firm instigated early-retirement. Until then, bonds pass hot potato-like from hand to hand in the secondary market.

Not all bonds are like this though. A retractible bond, or retractible debenture, is a different beast. Investors can choose to exercise the retractibility feature of this species of bond and force its issuer to buy it back. If we break down a retractable bond into its parts we see that it is a bond with an embedded put option. The put allows investors take the initiative and "reflux" the bond back to the issuer.

Retractability, or puttability, is a feature that gets often gets added to preferred shares and sometimes even common stock. The interesting thing about retractibility and puttability is that it turns what was once an exogenous hot potato asset into a semi-endogenous instrument. While investors can not "pull" retractible bonds or puttable stock out of an issuer, they can easily push, or "put", already-issued retractibles back to the issuer when those instruments are no longer desired.

How can we turn our semi-endogenous retractible bond or puttable share into a fully endogenous instrument? Let's consider another financial instrument, the gift card. Indigo, a bookstore up here in Canada, allows consumers to buy any quantity of gift certificates at the till. These gift certificates are puttable—their owner can immediately return the card for redemption. That the public can take the initiative in both buying unlimited amounts of gift cards and returning those coupons whenever they want qualifies them as fully endogenous. Not only is the "discount window"* for endogenous instruments like puttable gift certificates and ETF units always open, there is also a well-defined rule for pricing the emission of new units. Retractible bonds, which already have the put feature, would qualify as fully endogenous if their issuer were to set up a "window" with a set of rules so that investors could draw out new bonds on their own accord.**

Because endogenous and exogenous instruments are structured differently, they act in peculiar ways when market conditions change. When the demand for an exogenous instrument like GE stock increases, its price will quickly rise to meet that demand while its quantity stays fixed. When demand falls, the only way for investors to rid themselves of GE is to bid its price down until it reaches a real value at which the market willingly holds it. Things work differently with endogenous instruments. When the demand for an endogenous instrument like a coupon or gift certificate increases, its quantity quickly rises whereas its price stays fixed. When demand falls, investors can exercise their put option and send them back to their issuer. In sum, prices do all the work in exogenous adjustment whereas quantities do all the work with endogenous adjustment. Exogenous issuers can choose the quantity of their issue, but not the price, whereas endogenous issuers can choose the price but not the quantity.

So back to the great debate. Is money endogenous or exogenous? If money is defined as a certain narrow set of financial instruments (cash + deposits, M1, M2, whatever) then we need to appraise each instrument's structure to see whether its issuer provides an associated discount window and embeds a put option—or not. A quick glance through the instruments found on the narrowest lists of money (say M1) shows that almost all of these instruments have embedded put options and discount windows, so narrow money is primarily endogenous.

This is different from a few centuries ago when gold and silver constituted a significant share of the narrow money supply. Since the only way to get rid of an ounce of metal is to pass it on, gold, like stock, is exogenous and immortal, with the very same gold coin once used 5000 years ago still circulating today, though perhaps in bar form. Modern monetary economists are beginning to add exogenous assets like t-bills, bonds, and other AAA-rated debt securities to the list of money since these assets can be easily collateralized. In doing so, economists are slowly returning to a world in which a larger percentage of the assets on the list of money are exogenous.***

And finally, there's the moneyness, or liquidity, view. From this perspective, there is no limited list of money-items. Rather, all assets provide varying degrees of money-services. Put differently, moneyness is a vector which spans all assets. Because it inheres to a degree in all assets, moneyness is both endogenous and exogenous. After all, the universe of assets is comprised of both types of assets. A change in the demand for liquidity/moneyness results in a complex shift in prices and quantities. Liquid endogenous instruments are drawn out of issuers and less-liquid endogenous instruments refluxed back to issuers. Liquid exogenous instruments rise in price while less liquid exogenous instruments fall in price.
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*In modern days, the discount window refers to a central bank's ability to lend. In the old days, banks had actual "windows" behind which stood a bank officer who would accept securities in return for bank deposits or cash. A "discount" to its market value was applied to the securities, a sort of haircut that also provided the banks with income. See this image from the Philly Fed.

**A bank deposit is the quintessential endogenous instrument. There are multiple windows for buying a deposit -- one can either sell cash to get deposits, or sell personal IOU to get them, with each window offering different rules and rates. When deposits are no longer needed, one can "put" them back at any point by requesting cash or a return of one's personal IOU.***With the emergence of Bitcoin, Ripple XRPs, and the other alt-currencies, we're seeing the return of exogenous monies with a vengeance.

Note: For more on reflux, I'd definitely recommend Mike Sproul's The Law of Reflux. For more on exogenous money, Nick Rowe is who you should be reading.

This is a huge topic, but I just want to make a tiny point. The "zero bound" problem that is troubling the world's central banks is a consequence of endogenous non-interest-bearing paper money. If NIB paper money were made semi-exogenous (redeemable on demand, but not issued on demand), then a central bank could set an arbitrarily negative interest rate. Rather than causing an explosion in the quantity of paper (to no effect), it would cause the value of paper to rise above face value (in other words, paper money would temporarily cease to be "currency", but it would still be the hand to hand medium of exchange).

I like to tease monetarists by putting it this way: the way to ease monetary conditions is to restrict the quantity of currency (superficially the exact opposite of the naive monetarist mantra of "just print money!")

"If NIB paper money were made semi-exogenous (redeemable on demand, but not issued on demand), then a central bank could set an arbitrarily negative interest rate."

Technically, Miles plan wouldn't make paper money semi-exogenous. People could still take out and withdraw cash whenever they wanted. What it would do is alter the pricing of the put option so that the option strike price is no longer set at par. You could only "put" dollars back to the Fed at a penalty. So if endogenous non-interest bearing paper money is the problem, a way to fix it is to change the wording of the put, not change endogeneity.

No, Miles idea is essentially to replace non-interest-bearing currency with interest-bearing currency. The way currency would obtain interest (either positive or negative, although he only considers the negative case) would be to continuously vary the exchange rate between currency and electronic money.

That's a great idea, but unlike Miles I don't see it as a quick fix to the zero bound problem. His plan would make existing Federal Reserve Notes less valuable, and that would never fly legally. It would be a default on the promise written on every bill.

The quick fix is to make FRNs *more* valuable, not less. There is no legal problem with that.

FRNs can function as a medium of exchange even if they are technically bearer bonds (trading at a premium to face value) and not currency. There is no need to introduce a new currency, although it would be desirable in the long run.

JP: for any other good, Q=min{Qs,Qd}. An individual either has an excess demand for that good and is trying to buy more, or else has an excess supply of that good and is trying to sell more, or else has the desired quantity and is neither trying to buy nor trying to sell.

For money, I don't even know what Q=min{Qs,Qd} means. An individual might be trying both to buy more money and sell more money at the same time.

The medium of exchange is not like other goods. Only car dealers, who both buy and sell cars, and hold inventories of cars, might be both trying to buy more cars and sell more cars at the same time. We all hold inventories of the medium of exchange.

(An aside: "endogenous/exogenous" aren't really the right words to describe what this debate is about. Even if gold were used as money, the stock would be endogenous, because the amount of gold being mined would depend on stuff, like the price of gold, and the wages of gold miners. The stock of money is almost always "endogenous" in the normal sense of the word.)

"An aside: "endogenous/exogenous" aren't really the right words to describe what this debate is about."

I can see that. Perhaps we're talking about the short vs long run? We probably all agree that in the long run, stocks adjust "endogenously". But in the short run what facilitates the adjustment? If a money-item has a "discount window" and an attached put option, I say that its quantity will quickly adjust. If it doesn't, then it's price will quickly adjust. Maybe that is not controversial at all?

"For money, I don't even know what Q=min{Qs,Qd} means. An individual might be trying both to buy more money and sell more money at the same time."

You've given a counterexample of car dealers. Another counterexample would be banks themselves. The first thing a bank does when it receives a competing bank's deposit is to "put" it back to the issuer in return for redemption media, whether that be central bank balances or gold. In other words, a bank never tries to both buy & sell a competing bank's money... it will only buy and reflux. If the deposit contained no put option (say the bank has an old fashioned option clause that allows it to temporarily suspend redemption), the only way to get rid of a competing bank's deposit would be to spend it onwards hot potato-like. The deposit has become exogenous.

If we are being *very* strict about terminology, things are never "exogenous" or "endogenous" in themselves, but only within the context of a given model. E.g. weather is exogenous in economics models, but endogenous in meteorological models.

About the only historical case I can think of where the stock M would be truly exogenous with respect to standard macro variables would be: where the central bank follows a k% rule. M is endogenous under inflation-targeting, and would be even if the BoC literally used helicopter and vacuum cleaner operations to adjust M. Because almost anything could affect inflation for given M (or M for given inflation), so the BoC would make the helicopters or vacuum cleaners operate in response to almost anything.

I think it might be better to argue about the "Law of Reflux" rather than "endogenous/exogenous" money?

"If a money-item has a "discount window" and an attached put option, I say that its quantity will quickly adjust. If it doesn't, then it's price will quickly adjust. Maybe that is not controversial at all?"

It's not controversial for nearly all economists. It's very controversial for a small minority of heterodox economists like me!

For starters, what does "its price" mean? Suppose the price of everything were sticky. Except peanuts, which have perfectly flexible prices. So the price of peanuts instantly adjusts until there is neither excess demand or supply for peanuts in terms of money, or excess demand or supply of money in terms of peanuts. But all that means is that the peanut market has continuous market-clearing. Should we then build macroeconomic theory on deviations between the market price of peanuts and the natural price of peanuts?

My old post on "the peanut theory of recessions": http://worthwhile.typepad.com/worthwhile_canadian_initi/2011/07/the-peanut-theory-of-recessions.html

1. Do you agree with me that there has been a historical argument that we call the banking vs currency school debate (also known as the exogenous vs endogenous money debate) that still crops up? (one example)?

2. Do you think that I've properly described the nature of the debate in terms of my metaphors ie. elasticity/reflux/helicopter? Let's leave endogenous/exogenous out of it... these terms seem to have inherited multiple meanings over the years. You'll note too that I haven't gone into macroeconomics.

3. Do you agree or disagree with my way of re-interpreting this debate in terms of finance theory, ie. put options + discount window? Do you have problems with the idea of looking through the various Ms to see which have these provisions?

If you agree with me up to here, is it mainly issues surrounding price stickiness that are bothering you? I've implicitly assumed fast adjustment in prices... but I'm biased since I tend to think in terms of securities markets. But on the whole I have no problem with price stickiness.

3. I think put options is the right way to look at it. But I think finance theory is unhelpful. Because when finance theorists say "put option" they implicitly assume the existence of something called "money" and that we get a specified amount of that "money" when we exercise our put option. So when we talk about put options on money itself we can no longer make that implicit assumption. We have to specify what good we get when we exercise our put option on money.

4. If all prices were perfectly flexible there could never be an excess demand or supply of any good, including money. It is only when (at least some) prices are sticky that we can argue about whether the Law of Reflux ("there cannot be an excess supply of money") is true or false.

3: "I think put options is the right way to look at it. But I think finance theory is unhelpful. Because when finance theorists say "put option" they implicitly assume the existence of something called "money" and that we get a specified amount of that "money" when we exercise our put option. So when we talk about put options on money itself we can no longer make that implicit assumption. We have to specify what good we get when we exercise our put option on money."

Ok. What if we're talking about the relationship between different types of money? For instance, deposit money could be thought of as having a put option on base money. And in the old days, base money had a put on gold money. Isn't it safe to use finance theory in this context? It lets us think more clearly about questions like what might happen when deposit money loses its put option, how does a bank run work, or what happened when the gold window was closed by Nixon etc.

Maybe these are different questions than the ones you like to ask. You're more macro than I am... I rarely stray into macro lest I say something dumb.

JP: " For instance, deposit money could be thought of as having a put option on base money."

Yep, and that is very important. (Actually, I'm tempted to say that deposit money is *nothing more than* a put option on base money, that also gets used as a medium of exchange.

But when the Law of Reflux guys argued that therefore there could not be inflation as a result of an overissue of deposit money, because if there were an excess supply of deposit money people would just exercise the put option, they were wrong. They were assuming there is only one market in which deposit money is traded, and therefore only one "excess supply" of deposit money. Even if there is market clearing between deposit money and base money, there can be disequilibrium in the many markets where both monies are traded for all other goods.

The finance guys need to think about what markets exist, and what "excess supply or demand" means when a good is traded in more than one market. And a medium of exchange, by definition, is traded in more than one market.

"But when the Law of Reflux guys argued that therefore there could not be inflation as a result of an overissue of deposit money, because if there were an excess supply of deposit money people would just exercise the put option, they were wrong... Even if there is market clearing between deposit money and base money, there can be disequilibrium in the many markets where both monies are traded for all other goods."

I feel like we're finally getting somewhere. You say that the put option on deposit money isn't necessarily exercised when there is an excess supply of deposit money. People have to spend it away. Someone like Glasner says that the put option is always exercised, reflux happens, and therefore deposit money has no effect on the price level.

So the difference between you two boils down to why (or why not) a deposit's put option into base money isn't exercised, or in a larger sense, why puttability does (or doesn't) apply to monetary phenomena.

I'm actually more interested in getting the question right than the answer.

Side note: Deposit money is more than just a put option since deposits that become inconvertible (think old Scottish banking) are still valuable. They lose the option feature, but become more like a debt instrument. Puttable stock doesn't lose its value when it is no longer puttable, it just becomes regular common stock.

JP: "I'm actually more interested in getting the question right than the answer."

That's certainly the harder part.

I think I got closest to getting the question right in this post: http://worthwhile.typepad.com/worthwhile_canadian_initi/2013/02/what-is-an-excess-demand-for-money.html

Assume 3 goods: apples, bananas, and money. Two markets: apples/money; bananas/money. Assume money is redeemable for apples, so there cannot be an excess demand or supply for apples in terms of money (or money in terms of apples). But (if the price of bananas is sticky) there can still be an excess demand or supply of bananas in terms of money (or money in terms of bananas), if the relative price of apples/bananas is wrong.

The real world is exactly like that model, except "bonds" replace "apples", and "all other goods" replace "bananas".

"Puttable stock doesn't lose its value when it is no longer puttable, it just becomes regular common stock."

Yep. But if it paid no dividends ever, and would never be puttable (or bought back) again in future, then it would lose all value. Unless it had such a high liquidity premium that some people would still hold some of it even at a negative real return. Which is what money has. So even when the promise of puttability eventually faded away to nothing, it retained some value.

Let me try to continue with the put/window language. So what you're saying is that many investors do exercise the put option on deposit money and do go to the discount window... but at the same time many investors are frozen out and can neither put nor discount.

Whenever the apple market has too much money, it gets putted back for apples, and when it has too much apples, people go to the discount window and draw out money. This is reflux. The problem is that there is no way for people in the banana market to draw money out of the discount window should there be an excess demand for money, and no way for them to put money back should there be an excess supply of money.

JP: when you say an asset is "redeemable" you have to say in what good it is redeemable.

Suppose the central bank offered to buy or sell unlimited amounts of money in exchange for...peanuts. I would describe that as "peanuts are redeemable (in money)". And it would mean there could never be an excess demand or excess supply of peanuts. And there could never be an excess demand or supply of money *in terms of peanuts*. But there could still be an excess demand or supply of money in terms of everything else.

Here is my post on that topic: http://worthwhile.typepad.com/worthwhile_canadian_initi/2013/02/what-is-an-excess-demand-for-money.html

Max: same question for you: When you say "If NIB paper money were made semi-exogenous (redeemable on demand, but not issued on demand)...", I would ask: redeemable for *what*? Bonds? Gold? Peanuts?

BTW, I think you are proposing (or leaning towards proposing) something very similar to Silvo Gessel's "stamped money". As a (quasi) monetarist, I fully agree that something like that would work, in principle. If there's an excess demand for money, causing a recession, you need to either increase the supply, or reduce the demand. Something like stamped money, or money that self-destructed at random, or whatever, would reduce the demand for money. (But it's easier in practice and more sensible to do the same thing by something like NGDPLPT.)

"Max: same question for you: When you say "If NIB paper money were made semi-exogenous (redeemable on demand, but not issued on demand)...", I would ask: redeemable for *what*? Bonds? Gold? Peanuts?"

For electronic money.

"BTW, I think you are proposing (or leaning towards proposing) something very similar to Silvo Gessel's "stamped money"."

No, I'm saying the solution is to let paper money trade at a premium to face value. At which point it technically won't be money any more - it will be bearer bonds - but that's acceptable, since bearer bonds can also be a medium of exchange.

Max: will paper money trade at a premium to face value, or will electronic money (*whose* electronic money?) trade at a discount to face value? Premium (or discount) relative to *what*? Why do the ink marks on paper money matter?

And why "technically" won't it be money, if it is used as a medium of exchange? Is it because it won't be used as a medium of account? How do you know people won't use it as a medium of account (and will, presumably, use electronic money instead?)?

How is your proposal different from raising the inflation target?

Try another thought experiment. Suppose the central bank made $20 bills redeemable on demand (for $1 bills) but not issued on demand. Would $1 bills trade at a discount, or $20 bills trade at a premium? Which bills would be "technically" money?

Max: or try this: Suppose the Bank of Canada's printer screwed up, and accidentally printed $21 instead of $20 on some bits of paper. But the Bank said "Ignore that. It's just a misprint. Those are really $20 bills." Would those bills still be technically money?

Watching this from the sidelines, but couldn't help notice that medium of account came up. Medium of account is CPI, folks ;)

Max's scheme could also be viewed as the authorities choosing two different MOAs (same with Miles Kimball's). E-money's MOA remains the CPI basket (declining at rate x% per year), whereas paper money's MOA is the CPI basket (declining at >x%) . If everyone chooses to publish prices in e-money and not paper dollars, we still have two MOAs. Just like bimetallism.

"Max: will paper money trade at a premium to face value, or will electronic money (*whose* electronic money?) trade at a discount to face value? Premium (or discount) relative to *what*? Why do the ink marks on paper money matter?"

The ink marks define what discharges a debt. "This note is legal tender for all debts, public and private." A $100 bill discharges a $100 debt.

Premium to face value means that a $100 bill trades above $100, in exactly the same way that a treasury bill with a face value of $100 can trade (and can sell at auction) above $100.

Of course, t-bills are not used as a medium of exchange, and I claim that technically-not-money FRNs would be. Why the difference? Because electronic money is always superior to t-bills as a MOE, but nothing would be remotely superior to almost-but-not-quite-money FRNs as a hand to hand MOE. You use the best thing available.

JP: Take the Indigo gift certificates. They could always be redeemed for books, so there could not be an excess supply of certificates *in terms of books*. Now they can be redeemed for money too, there also cannot be an excess supply of certificates *in terms of money*.

But money can always be redeemed for books (unless bookstores run out of books). Does that mean there cannot be an excess supply of money? Or does it mean there cannot be an excess demand for books (unless bookstores run out of books)?

Yep. You are one of the very best bloggers on money. But this post, though still good, is very deeply flawed.

The stock of (corporate) bonds may be historically determined, and currently inelastic, and they are not redeemable for anything in aggregate, but that does not mean they are a hot potato. If there is an excess supply of corporate bonds at the current price (all people hold more bonds than they wish to hold), people will *not* be able to pass them on.

Nobody (except bond dealers, who hold inventories of bonds) will buy a bond if he doesn't want to hold it. Everybody buys money all the time that they don't want to hold. They buy it in exchange for apples because they want to sell it in exchange for bananas.

Thanks for the compliment, Nick. Made my day. This dang blog takes enough of my time, so it's good to know that it's being appreciated.

Let's say that gold is money, and the stock of gold is inelastic. If everybody buys gold all the time that they don't want to hold, it is after all money, how do we ever get inflation? We can't, since any amount of new gold will be accommodated in people's inventories. To explain inflation/deflation, at some point gold money should begin to act like bonds... if there is an excess supply, people should cease being able to pass it on at current prices.

This blog is definitely admired and appreciated by me. (Except I get a bit pissed that I'm no good at doing lots of things you are so good at. But then I cheer up a bit when I see I rank second only to "Federal Reserve" on your labels!).

Frances just asked me about bitcoin. I said I couldn't get my head around it, and told her to read your posts.

Suppose I unexpectedly take my 4 cars to the local car dealer, and sell them to him at favourable prices because I need to leave the country quickly. After I leave his lot, his actual inventory is now 4 cars higher than desired. (It would be exactly the same if they appeared in his lot by magic helicopter.) He now tries less hard to buy cars and tries more hard to sell cars. He says "no" to more sellers, and says "yes" to more buyers. And/or he cuts his buying and/or selling prices.

It's exactly the same with money, where we are all dealers. If something causes our inventories of money to increase, we try harder to sell money and try less hard to buy money. So the price of money falls (the prices of all other goods rise).

This is like asking if apples enter the market exogenously or endogenously. The answer is that it's just EXCHANGE, and exogenous/endogenous are words that just don't describe the situation.

Think of silver spoons. If the world wants more silver spoons, then people will find it profitable to stamp some silver into spoons. If the world has too many silver spoons, people will find it profitable to melt those spoons, and they will reflux back to bullion.

Now think of silver coins. If we want more coins they will be minted. If we want less they will reflux to bullion. Whether we are thinking of coins or spoons, the words 'exogenous' and 'endogenous' just don't apply.

Now suppose that the mint master gets smart, and instead of issuing 1 oz coins to people who bring him 1 oz of silver, he starts issuing 1 oz paper tokens to people who bring him various assets worth 1 oz. of silver. Nothing changes. It's all just trade. We can add complications like "The mint declares that it will not redeem any paper tokens for silver until the mint is liquidated x years from now.", but the mint and its customers are still only going to deal with each other if they each expect to gain.

BTW: John Fullarton made a similar error when he spoke of "forced" currencies, like the assignats and continentals, and tried to distinguish between them and the un-forced currency issued by the Bank of England. In fact, the same factors determined the values of all of these currencies: If they were adequately backed they held their value. If they lost backing, they lost value.

1. Do you agree with me that there is/has been a historical argument that we call the banking vs currency school debate that continues to this day?

2. Do you think that I've properly described the nature of the debate in terms of my metaphors ie. elasticity/reflux/hot potato?

3. Do you agree or disagree with my way of re-interpreting it in terms of finance theory, ie. put options + discount window?

If you agree with all of that, are you just saying the distinction is superfluous? In that case, I'm not sure I agree with you. If a regular common stock loses backing, its price falls. If a puttable common stock loses backing, the entire issue quickly gets forced back on the issuer. The two different asset structures react differently to the same stimulus.

For example, suppose the government's only asset is 100 oz. of 'taxes receivable', and it issues 40 oz worth of paper IOU's (money) in exchange for 40 oz worth of land. The money is adequately backed and will hold its value, whether we consider it exogenous or endogenous. Now the government issues another 100 oz. of IOU's and gives them away. This reduces the government's net worth to zero, but there is still 140 oz of assets backing 140 oz. of IOU's, so still no inflation. I'm not sure if you'd call that latest issuance exogenous or endogenous, but once again I'd say that that's not what matters. Backing is what matters.

If the government then issues another 140 IOU's, and gives them away, then you'd probably call it exogenous, and Fullarton would have called it 'forced'. I'd say that each IOU would lose half its value because backing per IOU has been cut in half. It wouldn't matter if those IOU's were called 'puttable', since the government is not capable of buying back its IOU's at more than 0.5 oz. each. Of course, if the original dollar holders had expected this loss of backing, they wouldn't have accepted the original IOU's in the first place. You could say that they have been defrauded, but once again it's irrelevant whether we call it exogenous or endogenous.

"It wouldn't matter if those IOU's were called 'puttable', since the government is not capable of buying back its IOU's at more than 0.5 oz. each."

This implies that if the IOUs were initially puttable, that put has now been removed. If the put were still in effect, upon recognition of government overissuance of 140 IOUs the quickest investors would have ran to the government and putted each IOU for 1oz until all ounces were gone. A bank run. The remaining IOU holders would have received nothing, since the kitty would have been empty. If the government forswears the put option before investors mob it for redemption, then there's no way for the quickest investors to rid themselves of their IOUs, except in the secondary market where their price would quickly fall to 0.5 oz each.

By the way Mike, when you reply, don't go to the bottom of the page where "add comment is". Hit the reply link right below my comment. That way your comment will be affixed directly below mine and our conversation will flow better.

Only go to "add comment" at the bottom if you want to start an entirely different comment.

I've read most of Mehrling's stuff. He's always well spoken and thought provoking. Not sure what happened to his blog. I used to comment there but it seems he's letting it slide.

One of the key ideas of the "moneyness viewpoint" is there in Mehrling's paper: whatever we consider to be money is context-specific and personal. Different things are money - or not - to different people. There's more to it than that, but that's key.

Later he says: "That is why the history of monetary theory so largely consists of a dialogue between two points of view, often distinguished as the Currency Principle versus the Banking Principle, which emphasize respectively the importance of scarcity and the importance of elasticity. From the point of view I have been developing, both of these intellectual traditions have part of the truth. but neither has it all, because liquidity is at the same time both scarce and elastic."

Lol, that sounds familiar. He's trying to figure out how to integrate the two viewpoints -- very hard to do, just take the comments section in my post is an indicator.

"If all prices were perfectly flexible there could never be an excess demand or supply of any good, including money. It is only when (at least some) prices are sticky that we can argue about whether the Law of Reflux ("there cannot be an excess supply of money") is true or false."

The language of 'sticky' is perverse and unhelpful.

All we need to get get money and imperfect prices is THE KNOWLEDGE PROBLEM.

Especially, all we need is the knowledge problem applied to the coordination of heterogeneous production goods and processes of varying output and time-cost, and changing consumption across time.

Imperfect prices and the knowledge problem are *not* captured by the notion of 'sticky prices'.

Imperfect price signals are a product of the knowledge problem, they are not a product of 'stickiness' -- you can't have perfect prices because of the knowledge problem, no matter how unsticky or sticky they might be.

Money is a product of the knowledge problem, things made difficult or impossible by the knowledge problem are made possible and more economical because of money.

Greg: at some future time, when we are all very wise, we won't talk about "sticky prices", and will talk instead about some sort of knowledge problem. But we are not yet that wise, and we don't know what sort of knowledge problem it is. So "knowledge problem" and "sticky prices" are equally handwaving.

Not entirely off topic: we've tried out hand at incorporating the (very, endogenous) concepts of monetary statistics into the fabric of endogenous money theory. What do you think about this? http://peemconference2013.worldeconomicsassociation.org/?paper=monies-debt-and-policy-the-concept-of-endogenous-money-as-a-basis-for-household-and-non-financial-companies-instead-of-bank-centered-monetary-statistics

Imagine that the US adopted Canadian style free banking at the start of the 20th century instead of central banking. That means gold as the base money used for redemption and interbank clearing, and the gold dollar as the unit of account.

In Chapter 13 of Larry White's "Theory of Monetary Institutions" ("Cashless Competitive Payments"), he mentions the Greenfield-Yeager Proposal, which includes:

1) multi-commodity stndard or MOA, to keep the price level more stable than a gold or other single-commodity standard

2) separation of MOA from medium of redemption (MOR); bank issued money is denominated in MOA bundle, but redeemable for indexed quantity of something more convenient (e.g. gold or other financial assets like stocks).

Various commodity bundles are suggested (ANCAP, etc), but choosing a standard bundle is always going to be a hassle. Also, a commodity bundle means redemption is going to have to be in something else (we can't expect banks to hold stocks of aluminum and plywood, right?)

My thought: if money had been free to evolve, would supermarkets eventually branch out into becoming money issuers, with "redemption" by shoppers in whatever bundles they deemed appropriate?

I'm thinking that supermarkets (which didn't emerge until the 1920s) like A&P and Krogers and big retailers like JC Penney and Sears would have started to offer their employees the option to receive pay in company scrip (until recently, Walmart actually did this in Mexico, but it was prohibited by the Mex Supreme Court).

The stores might also have allowed their customers to buy the same scrip at a discount, effectively giving the store a loan (like corp bonds). This would have been an important source of financing in the days before computers/communications made bond issues much easier.

By paying workers in company scrip (and selling it), the store would benefit from seigniorage and access to short term borrowing. As the circulation of scrip increased, the store would also benefit from float since workers and customers would not "redeem" the scrip all at once by shopping.

If the scrip became liquid enough, suppliers in the town might also start accepting payment in scrip. This would further benefit the store as well as the liquidity/circulation of the scrip (even today, trade credit is a huge source of finance for Walmart). Eventually, it would become a local money (which spread regionally as the store opened more branches).

Such a money would be "redeemable" in the stores for a baskets of goods determined by shopper preferences. The store would adjust the prices of goods for maximum profit. Wouldn't this be a practical way for money to be redeemable in commodity bundles as well as to stabilize the price level?

Please tell me if this sounds sensible, or I'm just ranting. I thought of this when I woke up this morning.